A recent report in The Economist predicting a banking crisis in Taiwan touched off fierce debates across the country. But both the supporters and detractors of the prediction agree that Taiwan's financial problems have reached a state where reforms are a do-or-die imperative. The Legislative Yuan's passage of the Financial Institutions Merger Law
Part of Taiwan's financial problems originated in the low NT$10 billion threshold set for the establishment of new banks after the government liberalized the financial sector. Too many banks popped up, resulting in vicious competition, which in turn eroded the quality of bank loans. On top of this, loose supervision of financial operations has allowed political and business interests to control the banks and use them like their family coffers. Loans issued to cronies on insufficient collateral is an increasingly serious problem that causes bad loan ratios to soar. Official statistics show Taiwan's banks have an average non-performing loan ratio of about 5 percent, but independent estimates put it at two to three times the official figure.
Local farmers' and fishermen's credit cooperatives are in even worse shape. Some cooperatives are running non-performing loan ratios of 60 to 70 percent and negative net worth. We have seen many bank runs at local cooperatives. It took forceful intervention from the Ministry of Finance and takeovers by other financial institutions to stop a domino effect leading to a string of bankruptcies. Seen in this light, a mini-financial crisis is not an improbable scenario.
The new merger law provides the basis for voluntary or compulsory mergers and acquisitions. It also provides incentives for such actions and allows the establishment of asset management companies to handle bad loans. There are quite a few important objectives behind the law. One, to improve the structure of the financial system and prevent a financial crisis; two, to encourage bank mergers and allow the banks to expand their economic scale so that they can better support industrial development; three, to speed up internationalization of Taiwan's financial industry after the country enters the WTO, when banks will be able to strengthen their competitive edge through mergers with foreign banks.
That said, financial mergers are by no means a cure-all for the structural problems facing our financial system. Mergers will have to be based on whether the partners in the deal can be mutally complementary. If one bank is forced to merge with another that is in a dangerous shape, it could cause even more damage to the partners and aggrevate problems. When the government designates strong banks for complusory mergers with the faltering ones, the consequent business pressures and losses will also become a focus of controversy in the future.
While encouraging bank mergers, the government should also strengthen the supervision of financial operations and encourage the banks to diversify their services. For example, traditional banks could be transformed into investment banks or industrial banks. The government should encourage innovation and professional management so that the banks can leave behind the vicious competitive cycle of loan interest rate wars and standards.
The government should also work to eliminate improper political and industry pressure on the banks, including loans issued to cronies and special interests, which have been the key reason behind the massive bad loans. By encouraging mergers that can help improve the financial system, eliminating cronyism and allowing for professional management, Taiwan can escape from the shadow of a financial crisis.
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